New York City has been among the hardest-hit regions during the pandemic, and this has had an outsized impact on the REITs that invest there. In this article, I’m focused on Vornado Realty Trust (
(Source: Company website)
A Look Into Vornado
Vornado Realty Trust is a well-known and established REIT that focuses on commercial properties located primarily in New York City. As a percentage of NOI, its property portfolio consists about 78% office, with the remainder attributed to retail, residential, and its 32% stake in Alexander’s (ALX), which is another NYC REIT. Outside of New York, Vornado owns the iconic 555 California skyscraper in San Francisco, CA, and theMART in Chicago, IL.
Although occupancy in the office portfolio remained strong at 96% at the end of Q2, its retail occupancy saw more challenges, with occupancy at just 84%. This was primarily due to Vornado’s exposure to J.C. Penney (JCPNQ) and other troubled retailers. J.C. Penney filed for Chapter 11 bankruptcy back in May and is in the process of closing 200 stores by the end of this year.
I see continued challenges for the office portfolio, as New York and the rest of the country are bracing for a potential third wave of COVID-19 in the fall and winter seasons. This is being reflected in the current leasing activity. According to a report by Cushman & Wakefield this week, leasing activity in the NYC area is down by almost 50% since last year, and tenants are currently subletting their unused space, with subleased spaces amounting to 25% of all available space.
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While the short term will undoubtedly be challenging, I do see reasons to be optimistic. NYC remains a highly desirable location for companies to do business. This is supported by an October 16th Forbes report that the tech giants Amazon (AMZN), Apple (AAPL), Google (GOOG), and Facebook (FB) are scooping up office real estate in NYC. I see this as being a strong offset to the traditional financial sector tenants that currently occupy most of NYC’s offices. According to the same report, tech jobs in NYC have boomed by about 80% over the last 10 years, and smaller companies are opening offices as well.
Looking forward, I expect Vornado to weather this crisis, and see a vaccine as a strong catalyst for a turnaround in tenant demand. This is supported by management’s comments on the desirability of the REIT’s properties and its lease durations, as noted on the last conference call:
“CEOs still view the offices as integral to operating their businesses in New York City, [which] has a deep and unique reservoir of talent. In addition, certain large companies in our portfolio that had positive renewal discussions at the outset of the crisis have now picked them back up as they focus again on the future and have the confidence that they need same in that space on a long term basis.
But to emphasize the point that Steve made earlier, the trend of users wanting to be in the best product with the most modern amenities and healthiest environments will only accelerate coming out of this health crisis. Importantly, as the market recovers from the COVID pandemic, our New York office expires through the end of 2022 are modest and portend well for stability of our cash flow, amounting to only 1.8 million square feet or 10% of our portfolio, an average of only 4% per year at a weighted average expiring rent of only $76.53 per square foot.”
In addition, Vornado appears to be positioning its retail portfolio for the future. Management envisions the Penn district as being the new “ecocenter” of New York, and has gotten positive receptions from prospective tenants and the brokers community on its PENN 1 and PENN 2 redesigns. I see this as a positive development as retail adapts to an e-commerce environment by shifting away from traditional department store concepts.
Turning to valuation, I wanted to calculate what Vornado’s NAV is. There are a number of ways to calculate NAV, and I chose to use the following model from iREIT.
Based on the methodology above, I arrived at NAV/share of $35.34 based on Q2 financials, and this translates into a Price-to-NAV of 0.93 based on the current share price of $32.83. This compares favorably to the Price-to-NAV of 1.74 as of 12/31/2019.
(Source: Created by author)
Looking at historical valuations, Vornado has rarely been this cheap, and not since the Great Financial Crisis have the shares taken a dip of this magnitude. The shares also appear to be trading at a substantial discount based on the blended P/FFO of 9.6, which sits far below the normal P/FFO of 20.5.
(Source: F.A.S.T. Graphs)
Analysts currently have a consensus Neutral rating with a price target of $41.67. This tells me that while the shares appear to be undervalued, investors should be prepared for volatility in the stock price due to near-term uncertainties around COVID-19.
Vornado Realty Trust has its fair share of near-term challenges as it navigates the current economic environment. However, I do find reasons to be optimistic, as NYC remains an attractive place to do business with a strong base of talent. This is supported by interest from tech companies, both big and small, that are interested in setting up shop in the area. While I expect near-term challenges to persist, I see better days ahead if and when this pandemic passes. As such, I see Vornado as being a good contrarian play for those who are long-term bullish on the NYC market.
Based on the valuation exercise and the aforementioned reasons, I see upside potential for the share price. More risk-averse investors who aren’t prepared for near-term volatility may want to wait for a better entry point.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VNO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.